Mexican inflation under control

Mexico’s inflation was lower than expected in the first two weeks of 2008, improving investors’ bets that the central bank could cut interest rates this year to protect the economy from a looming U.S. recession.

Consumer prices rose 0.27% in the first half of January, pushing 12-month inflation up 0.02% to 3.78%, the central bank reported on Thursday.

Closely watched core inflation, which strips out some volatile food and energy prices, was 0.25% during the period.

“The inflation data was good, and it points to a cut,” a Mexico City-based money market trader said. “The central bank has room to cut as long as inflation doesn’t get worse.”

Analysts in a Reuters poll on average had predicted 0.36% headline inflation and 0.35% core inflation for the first half of the month.

After the report was released, yields fell on interest rate futures contracts for the first half of this year. That meant investors were betting the central bank was more likely to lower its benchmark overnight rate from 7.5%.

Mexico’s central bank held its key overnight interest rate steady last week, after inflation for 2007 came in within its target range of 2% to 4%.

The bank expects inflation to surge above 4% for much of 2008 because of stubbornly high food prices and a new tax on businesses. Until recently, some economists had been watching for a rate hike in coming months.

Mexico’s central bank hiked interest rates twice last year as high food and energy prices threatened its inflation goal.

The U.S. Federal Reserve surprised markets Tuesday by slashing interest rates in an audacious bid to thwart a U.S. recession. Since then, yields on Mexican interest rate futures have fallen steadily.

During the first two weeks of January, higher prices for electricity, housing and domestic gas drove inflation, the central bank said. Lower prices for tomatoes and vacation deals helped keep a lid on costs.

A decline in the U.S. economy would hit Mexico, which sends most of its exports to its northern neighbor. Less economic activity in Mexico would probably weaken inflation.